Unemployment and Environmental Regulation in General Equilibrium

This paper analyzes the effects of environmental policy on employment (and unemployment) using a new general-equilibrium two-sector search model. We find that imposing a pollution tax causes substantial reductions in employment in the regulated (polluting) industry, but this is offset by increased employment in the unregulated (nonpolluting) sector. Thus the policy causes a substantial shift in employment between industries, but the net effect on overall employment (and unemployment) is small, even in the short run. An environmental performance standard causes a substantially smaller sectoral shift in employment than the emissions tax, with roughly similar net effects. The effects on the unregulated industry suggest that empirical studies of environmental regulation that focus only on regulated firms can be misleading (and those that use nonregulated firms as controls for regulated firms will be even more misleading). The paper’s results also suggest that overall effects on employment are not a major issue for environmental policy, and that policymakers who want to minimize sectoral shifts in employment might prefer performance standards over environmental taxes.